Relationship Between Corporate Governance and Earnings Management (Essay Sample)

THE RELATIONSHIP BETWEEN CORPORATE GOVERNANCE AND EARNING MANAGEMENT
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I acknowledge the role of my family in the success of this project. My family has been responsible for shaping me thus playing a critical role in the person that I am today. My friends and colleagues have also played a critical supporting role towards the success of this project. All this would not have been possible, however, were it not for the guidance of my supervisor as well as other academic staff who supported me in times of difficulty. The completion of this project would not have been plausible devoid of this assistance.
Executive Summary
This dissertation reflects the relationship between corporate governance and earnings management. This could be described as an investigation on whether governance practices poses and effect on financial matters. The study will examine the association between the audit committee and the traits of the board of directors. It also addresses the extent to which corporate earnings can be articulated by the use of discretionary accrual levels. Using the available firms from various categories of discretionary accruals, the study will be able to show that earnings management is associated with governance practices by both the board of directors and audit committees. The results give evidence on the effects of boards and audit committees on activities related to earnings management. The results have implications on various regulatory bodies such as Stock exchange bodies as they deal with financial reports that their legitimacy is under question. This is owing to the fact that financial reports may be solely based on the desires of the management rather than the firm’s objective
Glossary
ACIND is a variable that is coded 1 if the committee is made up of only independent non-executive directors
ACNMAN is a variable that represents the portion in percentage of independent non-executive directors who are not in a managerial position in any firm.
ACOPTION is a variable that represents the fraction of stock options to the total options and stocks being held by non-executive members.
FNEXPERT is a variable that if coded 1, there existsat least a financial expert as a member.
MANDATE is variable that is coded 1 when the committee is responsible for both the external audit and financial statement.
MEETINGS is a variable that is coded 1 if the frequency of meetings in a single year is more than twice.
BARDSIZE is a variable that represents the number of directors on the firm’s board.
BOARDIND is a variable that represents the portion of independent non-executive directors.
CEOCHAIR is a variable that is coded 1 if one person holds both the role of the CEO and chair.
NOMCOM is a variable that is coded 1 if the committee is composed of non-executive directors as a majority.
NXOWN is a variable that represents the cumulative share percentage that non-executive directors hold.
NXTENURE is a variable that represents the average years that a board of non-executive directors has served the firm
NXDIRSHIP is a variable that represents the average number of directorship positions in unaffiliated firms held by non-executive directors.
AGENCY is a variable that is coded 1 if the firm has a benefit plan for the directors and is based on their income
IPO is a variable that is coded 1 if the firm had an IPO in the year of study.
BIG6 is a variable that is coded 1 if the firm hired auditors considered being more professional than the others.
BLOCK is a variable that represents a cumulative percentage of shares held by shareholders with more than 5 percent of the organization’s shares and are at the same time unaffiliated with the management of the same firm
LNSIZE is a variable that represents the natural log of total assets.
SOX: Sarbanese Oxley Act
Table of Contents TOC \o "1-3" \h \z \u THE RELATIONSHIP BETWEEN CORPORATE GOVERNANCE AND EARNING MANAGEMENT PAGEREF _Toc396488911 \h 1Executive Summary PAGEREF _Toc396488912 \h 4CHAPTER ONE: INTRODUCTION PAGEREF _Toc396488913 \h 82.0 Introduction PAGEREF _Toc396488914 \h 172.1 Boards of Directors and Earnings Management PAGEREF _Toc396488915 \h 17Independence of Directors and Percentage Of Ownership PAGEREF _Toc396488916 \h 22Competency Level Of The Board Of Directors PAGEREF _Toc396488917 \h 242.2 Audit Committee And Earnings Management PAGEREF _Toc396488918 \h 26Independence Of The Audit Committee PAGEREF _Toc396488919 \h 26Audit Committee Competence Levels PAGEREF _Toc396488920 \h 30Activeness of the Audit Committee PAGEREF _Toc396488921 \h 31CHAPTER THREE: METHODOLOGY PAGEREF _Toc396488922 \h 33Research Purpose PAGEREF _Toc396488923 \h 33Research Approach PAGEREF _Toc396488924 \h 34Governance Variable PAGEREF _Toc396488925 \h 36Control Variables PAGEREF _Toc396488926 \h 39Empirical Model PAGEREF _Toc396488927 \h 42Results PAGEREF _Toc396488928 \h 42Descriptive Statistics And Analysis PAGEREF _Toc396488929 \h 42Multivariate Analysis PAGEREF _Toc396488930 \h 47Audit Committee Characteristics PAGEREF _Toc396488931 \h 48Board of Director Characteristics PAGEREF _Toc396488932 \h 51Discussions PAGEREF _Toc396488933 \h 54CHAPTER FOUR: CONCLUSIONS AND RECOMMENDATIONS PAGEREF _Toc396488934 \h 58References PAGEREF _Toc396488935 \h 59
CHAPTER ONE: INTRODUCTION
Introduction
In the contemporary business environment, there is a high potential for conflict between the interests of the owners of the organization and the other management parties best exemplified by lead organizations. More often than not, this conflict is also present when meeting the demands and expectations of the minority shareholders (Alexander, 2010). The expectations and demands of these different parties often put the management team in a quagmire of sorts. Neglecting the needs and expectations of any party might culminate in disgruntlement of the said party thus culminating in discontentment. Given this management problem, trust has to be given utmost regard, especially in financial matters.
Management is responsible to shareholders and the other players who benefit from the good performance of the organization (Klein, 2002). Each of the relevant players in the organization has their reasons as to why they need the business to perform well in the business world. With this being said, each of the players tends to focus on the ability of the firm to meet their needs. As such, a conflict of interest arises whereby each organizational player tends to refocus the goals of the organization such that it is best-positioned to realize their specific goals (Bédard, Chtourou, and Courteau, 2004). Given that each organizational player has his or her own level of authority, a conflict of interest becomes a pertinent issue. As such, the level of authority characterizing each organization player is at fault for the existence of this conflict of interest (Matsumoto, 2002).
In the past couple of years, the business field has been mired with cases of fraud that have often culminated in the failure of otherwise large organizations (Larcker, Richardson, & Tuna, 2007). High profile cases of fraud have negatively affected the integrity of the business world in the eyes of the public (). Suspicion has thus been a constant element when analyzing the interaction between the business class and the general public class (). In a bid to protect the public from poor management of listed organizations, the government has put in place measures to protect the public. One of these measures is the Sarbanese Oxley Act that was instituted in the year 2002 by the then American government (Anderson, Mansi & Reeb, 2003).
The Sarbanese Oxley Act (SOX) ushered in a new era where the management teams of organizations were required to act along with the provisions of the law. Corporate governance has thus to be realized via adhering to the provisions of the said act. The term corporate governance is used in reference to the rules and processes that are used to direct and control a firm. It is via the use of corporate governance that a firm is able to create a balance between the unique interests of the different organizational players. SOX dictated the nature of the interaction of the organization with both the audit committee and the board of directors. Amongst other provisions, SOX points out the expected responsibilities of the CEO and the CFO as pertains to the role in the production of financial reports. The SOX has provided a means via which the government has been able to control the operations of the corporate world (Park and Hyun-Han, 2003). In a world where fraud has become rampant, there is a need for government measures that inhibit the perpetuation of this trend.
There have been numerous arguments that have been put forward as to the most potent means of dealing with the conflicting interests of the different company shareholders. It has been asserted that when the shares of the organization are distributed over a large number of shareholders, it is possible to realize a good separation between the ownership demands and the needs for operational management (Cornett, Marcus, & Tehranian, 2008). In such cases, there is reduced potential for any single shareholder to have sway over any management decision. As such, the management team can create a balance between meeting the operational needs of the organization and the needs of the shareholders. Separation of ownership and operational needs i...